Will Iranian Oil Embargo undermine European economy?

At first glance it would appear as though the economic noose is beginning to tighten around Iran. In a rare example of cohesion, the U.S. has successfully pushed for sweeping Western sanctions against the Islamic Republic targeting its oil and banking systems in an attempt to squeeze the country’s pocketbook. The lynchpin of these sanctions is the EU decision to implement a defacto embargo on all of its imports of Iranian oil. While this seems to be a step toward greater Western unity in response to Iran, the question remains to what extent this will prove successful in forcing Iran to come clean on its nuclear program, and whether Europe can afford the cost.

There are two major factors that must be considered. The first is that the EU is extremely vulnerable to a shutoff of Iranian crude imports; an embargo effectively cuts off a massive source of oil needed to fuel faltering European economies. The second, and compounding factor, is that there is great uncertainty as to whether alternative sources can be found quick enough to replace the Iranian supply.

While the EU flounders in trying to contain the consequences of its threat, Iran’s government has done them one better by upping the ante. The Iranian regime threatened immediately to halt any oil exports to Europe. Based on the European consumption of Iranian oil, this action could deal a major blow to an already financially unstable Europe. The EU sanctions were not to take place until July 2012, giving them some time to secure alternative sources. Now, reportedly, Europeans will need to find a new oil provider as early as Friday. The Iran parliamentary vote to halt oil exports to Europe has been postponed while the visiting UN inspectors investigate the Iran’s nuclear facilities. That, coupled with the recent threats of closing off the Strait of Hormuz, leads to a precarious situation for the assurance of oil from OPEC’S second largest oil producer.

Greece, Spain, and Italy all depend on oil from Iran. One-third of Greece’s oil comes from the Islamic Republic, Spain receives 15%, and Italy receives 13%. As the EU tries to disentangle itself from the mounting debt crisis, this embargo might end up costing Europe more than it does Iran. It seems questionable as to whether or not Greece can sustain the dissolution of Iranian oil contracts when 30% of its daily consumption is in jeopardy.The second point is the sustainability of oil production from alternative countries such as Saudi Arabia or Libya. According to OPEC, the EU received 890,000 barrels per day from Iran in 2010. Making up for this difference poses a serious challenge. Currently, Saudi Arabia produces near 10 million barrels per day, but reportedly its maximum capacity is 12.5 million barrels. However, unbeknownst to many, Saudi spare capacity consists largely of heavy crude. This type of oil is undesirable due to its high cost in refining and environmental impact.

Transportation poses yet another challenge. The complexity of the energy market can dictate significant price swings depending on the market purchased from. If Europe manages to recoup its shortfall by increasing crude trade volume with Saudi Arabia, the Gulf states, or North Africa, the costs will likely be minimal. If, however, they have to go to Latin American, or East Asian markets, the transportation costs could have a significant impact at the pump.

Additionally, it is unclear how successful these economic sanctions will be when China and India are still importing Iranian crude. China is the world’s second largest oil consumer, and its officials have voiced displeasure with the recent embargo. In 2011 China increased its imports of Iranian oil by 30 percent. Meanwhile, Kuwait has just announced a $9 billion investment in a Chinese oil refinery, a staggering amount pointing to China’s appetite for oil. Some analysts linked the investment to the Persian Gulf monarchies attempt to convince China to stop its imports from Iran.

Oil prices have risen this week after the embargo was announced but that did not stop the Iranian rials from plummeting even further as pressure increases. This oil stalemate might continue leading to the deterioration of both the Iranian and European economies. The stage has been set and it remains uncertain as to who will derail course first in this geo-political game of chicken.Jessica Koontz is an Energy Policy Analyst at the Institute for Gulf Affairs